The Daily Record - December 9, 2005 Edition
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REDUCING YOUR 2005 TAX BILL AND PLANNING FOR 2006
by Mark J. Kovaleski, CPA
Individual income taxes, whether paid through employer withholding or quarterly estimates, are probably one of your largest annual expenditures. You may want to consider the following opportunities to reduce or defer your annual tax obligation.
IRA, Retirement Savings Rules for 2005
More tax-saving opportunities continue for retirement planning in 2005 than in previous years due to the availability of Roth IRAs, changes that make regular IRAs more attractive, and other retirement savings incentives.
Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2005 is $4,000.
For 2005, a $500 "catch-up" contribution deduction is allowed for taxpayers age 50 or older by the close of the taxable year who meet the other qualifications for IRA deductions. Thus, the total deductible limit for these individuals may be as high as $4,500.
401(k) Contribution: The 401(k) elective deferral limit is $14,000 for 2005, up from $13,000 in 2004. If your 401(k) plan has been amended to allow for catch-up contributions for 2005 and you will be 50 years old by December 31, 2005, you may contribute an additional $4,000 to your 401(k) account, for a total maximum contribution of $18,000 ($14,000 in regular contributions plus $4,000 in catch-up contributions).
Deduction Planning
Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer, remember to keep the following in mind:
Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.
State Taxes: If you anticipate a state income tax liability for 2005 and plan to make an estimated payment, consider making the payment before the end of 2005. Note that in 2005, you can choose to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes. This choice expires at the end of 2005, so if there is a plan to purchase a big ticket item, like a car or boat, which the sales tax paid can lead to a higher deduction, it would make sense to purchase it before year end.
Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2005 even though you will not pay the bill until 2006.
To avoid capital gains, you may want to consider giving appreciated property to charity.
Education and Child Tax Benefits
Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year's return. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers.
Credit for Adoption Expenses: For 2005, the adoption credit limitation is $10,630 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $10,630 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $159,450 and $199,450.
HOPE Credit and Lifetime Learning Credit: The maximum HOPE credit is $1,500 (100% on the first $1,000, plus 50% of the next $1,000) for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for only the first two years of the student's post-secondary education.
The Lifetime Learning credit maximum in 2005 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent.
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any "qualified education loan." The maximum deduction is $2,500.
Qualified Higher Education Expenses: For 2005, you also may be eligible to deduct qualified tuition and related expenses as an above-the-line deduction. Note that, unless extended, 2005 is the last year for this deduction.
Energy Incentives
Alternative Motor Vehicle Credit: Although not available until tax year 2006, if you are planning to purchase a motor vehicle powered by certain alternative fuels, you may need to act in a hurry. A credit, dollar amount depending on fuel savings and weight of the vehicle, is available for vehicles placed in service after December 31, 2005. The most popular vehicles subject to the credit are hybrids. Credits are also available for lean-burn technology vehicles, qualified fuel cell motor vehicles, and qualified alternative fuel motor vehicles.
Residential Energy Efficient Property Credit: If you plan on installing certain energy efficient property, such as photovoltaic, solar water heating or fuel cell property, it will be worthwhile to wait until 2006. Beginning in 2006, a credit is available for the expenditures incurred for such property up to a specific dollar limitation.
Nonbusiness Energy Property Credit: If you plan on remodeling your home and you plan on incorporating specific energy efficient property, it will be worthwhile to wait until 2006. Beginning in 2006, a credit is allowed for the purchase of qualified energy efficiency improvements. Such property includes advanced main air circulating fans, natural gas, propane, oil furnace or hot water boiler, windows, insulation material, exterior doors, etc. that meet certain energy efficiency standards.
Alternative Minimum Tax
Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for us to analyze your AMT exposure.
